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3 Critical Flaws That Toppled DeFi Protocols This Bear Cycle

Decentralized finance (DeFi) is stagnant. The hype of recent years has subsided, and several protocols have failed to gain traction.

Since its all-time high in December 2021, DeFi collateral has dropped by 77.6%. The drop is greater than the 71% drop in crypto markets.

Furthermore, many of the hundreds of new protocols have simply failed. According to researchers, there are three main reasons for this.

DeFi analyst ‘CyrilXBT’ suggested three critical flaws weighed down DeFi protocols this cycle on Jan. 10.

“Most Defi protocols have poor risk management, insufficient revenue, and excessive leverage,” he explained.

Systemic risk reduction is critical to the success of a DeFi platform. Numerous hacks, exploits, cross-chain bridge attacks, compromised smart contracts, and rug pulls occurred in 2022.

Last year, crypto and DeFi losses totaled $3.9 billion, according to a recent report. Poor risk management is a recipe for disaster for any DeFi protocol.

Another critical factor is the ability to generate revenue while remaining profitable. The researcher made the following observation:

“One of the most frequently cited reasons for DeFi protocols struggling is their inability to generate sustainable income that adds meaningful value to the platform’s ecosystem.”

Tokenomics that are poorly designed and have high inflation rates are a red flag. Because high inflation increases token supply, liquidity leaves the ecosystem if the token value does not hold.

Overexposure to leverage is the third critical factor. Users taking over-leveraged positions trapped protocols that had tokens that could be used as an asset to borrow loans.

Some of last year’s major meltdowns, such as Celsius and Three Arrows Capital, were also caused by leverage (3AC).

DeFi will resurface stronger, but only the protocols that avoid these three critical flaws will likely survive.

The top of the DeFi pile has been reshuffled. Lido, a liquid staking platform, has dethroned stablecoin pioneer MakerDAO.

Lido has the highest market share of all DeFi protocols, according to DeFiLlama, at 13.8%. Furthermore, it has a total locked value of $6.6 billion, which is slightly higher than Maker’s $6.4 billion.

Lido has recently been on a roll as liquid staking derivatives gain traction ahead of Ethereum’s Shanghai upgrade.

With $4.3 billion in collateral locked, Curve Finance is the third largest DeFi protocol. Furthermore, the total for the entire ecosystem is $47.6 billion, a 74% decrease over the previous year.


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